Flinders may lose 'world's most likely deal to fail' tag

While OAO Magnitogorsk Iron & Steel's takeover of Australia's Flinders Mines is seen as the most likely deal in the world to fail, traders can still double their money betting another bidder will buy Flinders.

Flinders, which is developing an iron-ore mine in WA's Pilbara region, has tumbled 13 per cent in the week since a Russian court deferred a ruling on the company's $554 million takeover by MMK, as the Russian steelmaker is known, until after the June 30 bid deadline.

Flinders is now trading 53 per cent below MMK's offer, the widest gap of any pending deal greater than $100 million, according to data compiled by Bloomberg. That indicates merger arbitragers are convinced the takeover is the most likely to collapse.

If the deal unravels, companies from Rio Tinto to Fortescue Metals and South Korea's Posco could emerge as bidders for Flinders, which controls one of the last independent deposits of its size in Australia, Investec Bank Australia said.

With the potential to yield as much as 25 million metric tons of iron ore a year, the mine could be worth as much as $911 million to a buyer even if iron-ore prices drop 40 per cent from current levels, according to Ord Minnett.

“The project has significant inherent value,” Luke Smith, a Melbourne-based analyst with Ord Minnett, said. “You can stand at this project and look straight down the valley and see Rio's rail line. You can stand and look the other way and see 25 kilometers away Fortescue is building the Solomon hub. It is in quite a privileged position geographically.”

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Diamond mines

Flinders declined to comment on speculation in an e-mailed response to questions.

“We will be doing everything we can to close the deal as we took this obligation under the agreement with Flinders,” Kirill Golubkov, Magnitogorsk, Russia-based MMK's spokesman, said this week.

Founded as a diamond miner, Flinders discovered in 2007 that it was sitting on a deposit of iron ore between others controlled by Rio Tinto and Fortescue, the world's second- and fifth-largest iron ore exporters. The discovery, of what was initially estimated to be up to 390 million tons of iron ore, prompted the company to change its name from Flinders Diamonds in 2008. Flinders last year raised its projection of the deposit's size to 917 million tons.

Estimating the cost of developing the mine at more than $1 billion, Flinders hired Citigroup for advice on its strategic options in September and agreed on Nov. 25 to be sold to Russian billionaire Victor Rashnikov's MMK for $554 million in cash, almost twice Flinders' market value at the time, according to data compiled by Bloomberg.

'Reasonably stunned'

Flinders' iron-ore deposit is of high enough quality to be shipped without processing and close to the rail and port infrastructure from which most of Australia's iron ore is exported, said Andrew Shearer, a Melbourne-based resources analyst at Octa Phillip Securities. Both factors would appeal to other buyers, he said in a telephone interview.

“I'm still reasonably stunned that Rio didn't put their hand up with a counter bid,” Colin McLelland, a Sydney-based analyst at Investec, said.

“It's 917 million tons, which is big in anyone's language. If you do want to get a footprint in the Pilbara - and there are still people that don't have one that maybe would like one - they are the only way to do it really.”

Flinders traded as high as MMK's 30 cents a share offer by March, with MMK saying it expected to close the deal in April. Flinders' shareholders approved the takeover on March 30. The same day, a Russian court ordered MMK not to proceed with the acquisition.

Shareholder lawsuit

The order came after Elena Egorova, who owns less than 0.001 per cent of the Russian company according to MMK, filed a lawsuit arguing that the deal discriminates against her interests as a shareholder.

Egorova could not be located for comment, and MMK said it has had no direct contact with her. The only information about her on the court website indicates she is registered in Siverskoye village.

Flinders was already down 47 per cent from its April 2 high when a court in Chelyabinsk, MMK's home region, said last week it wouldn't hear Egorova's claim until July 2, two days after the so-called quit date for the takeover passes. The shares have dropped another 13 per cent since the May 24 court decision. MMK's offer is 114 per cent above Flinders closing price of 14 cents yesterday, the widest spread of any pending takeover greater than $100 million, data compiled by Bloomberg show.

Lost opportunity

With steel prices falling, and MMK facing a downgrade of its debt rating by Fitch Ratings, the Russian company will have trouble financing the takeover, which includes the commitment for a $1 billion investment in the mine, according to Dmitry Smolin, an analyst at Uralsib Capital in Moscow.

Hot rolled coil export prices from Russia and other former Soviet republics dropped as low as $577.50 a metric ton in December, slumping 27 per cent from a peak of $790 a ton in February 2011, according to Metal Bulletin data. Iron ore rose 49 per cent last year. MMK reported its first annual loss in a decade last month, data compiled by Bloomberg show.

“We don't believe the deal with Flinders will be closed,” Smolin said in a telephone interview. “If the deal will be broken, that would be good for MMK.”

MMK's Golubkov said in an e-mailed response to questions that the takeover's collapse would be a “lost opportunity” for the steelmaker.

The deal's failure would give Rio Tinto, Fortescue and Atlas Iron Ltd. a chance to acquire Flinders, according to Ord Minnett's Smith. Brazil's Vale SA is “looking to diversify” and may also be interested, said Octa's Shearer.

Strongest candidate

With a single month of Rio Tinto's annual free cash flow of about $8 billion exceeding MMK's current offer, Smith said the London-based mining company is the strongest candidate to replace MMK as a buyer of Flinders.

“If you can have a project producing 25 million tons, which this project has the potential to, it is a Rio-sized project,” he said. Rio Tinto produced 231 million tons from its Pilbara mines last year, and plans to increase output to 283 million tons a year by the end of 2013.

Fortescue, which had $US2.5 billion in cash at the end of December, is developing the Solomon hub, comprising iron ore mining and a rail line to Port Hedland, to the east of Flinders' asset. Atlas Iron, with $377 million in cash, has made more than 20 acquisitions in less than a decade, the largest of which was last year's purchase of iron-ore explorer Giralia Resources NL for $758 million in stock, data compiled by Bloomberg show.

Fortescue, Vale

Bruce Tobin, a Melbourne-based spokesman for Rio Tinto, declined to comment on market speculation, as did Yvonne Ball, a spokeswoman for Perth-based Fortescue. An outside spokesman for Perth-based Atlas Iron wasn't immediately able to comment.

Vale, the world's largest iron-ore producer, said last year it will make “opportunistic” acquisitions. A representative for Rio de Janeiro-based Vale said the company doesn't comment on market speculation.

Flinders “are relatively close to the port compared to some of the competition, and they have a reasonable resource so it would make sense for somebody who is interested in gaining access to production to get involved at this stage,” said Peter Rudd, a Melbourne-based mining and resources manager at Private Wealth Pty Ltd.

South Korean steelmaker Posco may be among them, according to Investec's McLelland. Posco earlier this year agreed to buy a stake in Hancock Prospecting Pty Ltd.'s Roy Hill iron-ore project in Australia for $1.5 billion. With $US1.9 billion in cash and short-term investments at the end of December, Posco said in April that it will maintain investments in “necessary areas” including mining assets.

Australian priority

Kim Ji Young, a Seoul-based spokeswoman for Posco, said the company had not considered a bid for Flinders and that Roy Hill will be the company's priority for investment in Australian mining assets.

While Flinders is currently planning to produce up to 15 million metric tons of iron ore annually from the mine, the project's capability could be as much as 25 million tons, according to Ord Minnett's Smith. At that scale, even a buyer who projects iron-ore prices will average $80 a ton over the long term could offer as much as 50 cents a share, or $911 million, for the developer, Smith wrote in a May 29 report.

Iron ore currently trades at $134.80 a ton, according to data from The Steel Index. Average prices won't fall below $120 until at least 2015, forecaster WoodMackenzie said on May 21.

'Big issue'

Flinders needs a deal to finance the first stage of the mine's development, which could cost up to $488 million, according to a study the company published in January 2011.

“Funding is the big issue depressing the price,” said Mike Harrowell, senior resources analyst at BBY Limited, in an e-mailed reply to questions. Flinders had $24 million in cash on its balance sheet at the end of December, down by almost half from a year before, data compiled by Bloomberg show.

The fact that Flinders and its shareholders already agreed to a sale at 30 cents a share may also make that a cap on the possible takeover price, Octa's Shearer said.

“The MMK bid was on par with the value of the asset,” he said. “Another bid would likely come at a similar price.”

A deal completed at the same price as MMK's offer would still enable investors who buy the shares today to more than double their return, data compiled by Bloomberg show.

Flinders' “management has shown they're prepared to deal on the asset,” Shearer wrote in a May 30 note. “The resources remain an attractive acquisition target.”